Financial Planning & Control of Garments Industries: A Study on Li & Fung (Trading) Ltd.
ORGANIZATIONAL PROFILE
Introduction
IDLC Finance Limited commenced its journey in 1985, as the first ever leasing company of the country. In 1995, IDLC was licensed as a Financial Institution by the country’s central bank, Bangladesh Bank, following the enactment of the Financial Institution Act 1993. Over the last two decades, IDLC has grown in tandem with the country’s transition into a developing country and has emerged as Bangladesh’s leading multiproduct financial institution. To encapsulate the evolving nature of the company, IDLC has changed its name to IDLC Finance Limited from earlier Industrial Development Leasing Company of Bangladesh Limited in August 2007. Since 1985, when IDLC was formed as the pioneering leasing company in Bangladesh, the company continues to evolve as an innovative financial solutions provider. It is now able to offer its customers, integrated and customized financial solutions – all under one roof. Its wide array of products and services range from retail products, such as home and car loans, corporate and SME products including lease and term loans, structured finance services ranging from syndications to capital restructuring and a complete suite of merchant banking and capital market services.
IDLC Finance Limited is a multi-product financial institution, established in 1985 with the collaboration of reputed international development agencies such as:
Korean Development Leasing Corporation (KDLC), South Korea
Kookmin Bank, South Korea
International Finance Corporation (IFC) of the World Bank Group
Aga Khan Fund for Economic Development (AKFED)
German Investment and Development Company (DEG)
The primary goal of IDLC was to help modernize the financial services industry, by introducing modern modes of financing hitherto unknown to Bangladesh. This, we set about to do, by pioneering the launch of a multitude of financial products and services.
History-Key Milestone
Table 1: Key Milestone of IDLC Finance Limited
| May 23, 1985 | Incorporation of the Company |
| February 22, 1986 | Commencement of leasing business |
| October 01, 1990 | Establishment of branch in Chittagong, the main port city |
| March 20, 1993 | Listed with the Dhaka Stock Exchange Limited |
| February 07, 1995 | Licensed as Non-Banking Financial Institution under the Financial Institutions Act, 1993 |
| November 25, 1996 | Listed with the Chittagong Stock Exchange Limited |
| May 27, 1997 | Commencement of Home Finance and Short Term Finance operations |
| January 22, 1998 | Licensed as a Merchant Banker by the Securities and Exchange Commission |
| January 15, 1999 | Commencement of Corporate Finance and Merchant Banking operations |
| January 29, 2004 | Opening of the first retail focused branch at Dhanmondi |
| June 29, 2004 | Opening of Gulshan Branch |
| November 22, 2004 | Launching of Investment Management Services “Cap Invest” |
| February 07, 2005 | Issuance of Securitized Zero Coupon Bonds by IDLC Securitization Trust 2005 |
| January 02, 2006 | Opening of SME focused branch at Bogra |
| April 06, 2006 | Opening of Branch at Uttara |
| May 18, 2006 | Opening Merchant Banking Branch in the port city of Chittagong |
| July 01, 2006 | Relocation of Company’s Registered and Corporate Head Office at own premises at 57, Gulshan Avenue, Dhaka |
| September 18, 2006 | Commencement of operation of IDLC Securities Limited, a wholly owned subsidiary of IDLC |
| March 14, 2007 | Launching of Discretionary Portfolio Management Services “Managed Cap Invest”, renamed as “Max Cap Invest” |
| August 05, 2007 | Company name changed to IDLC Finance Limited from Industrial Development Leasing Company of Bangladesh Limited |
| December 03, 2007 | IDLC Securities Limited Chittagong Branch commenced operation |
| December 18, 2007 | IDLC Securities Limited DOHS Dhaka Branch opened |
| January 06, 2009 | IDLC Finance Limited and IDLC Securities Limited opened Sylhet branches |
| August 09, 2009 | IDLC Securities Limited inaugurated its Gulshan Branch |
| August 26, 2009 | Inauguration of Gazipur SME Booth |
| September 09, 2009 | Opening of Imamganj SME Booth |
| February 03, 2010 | IDLC started its operation at Narayanganj |
| February 24, 2010 | Inauguration of Savar Branch |
| August 08, 2010 | IDLC opened its 2nd branch in Chittagong at Nandankanon |
| October 27, 2010 | IDLC stepped in Comilla |
| December 2010 | IDLC inaugurated its Narsingdi and Keranigonj Branches |
Mission, Vision and Objective of IDLC Finance Limited
Vision
Become the best performing and most innovative financial solutions provider in the country.
Mission
Create maximum possible value for all the stakeholders by adhering to the highest ethical standards.
For Customers: Relentless pursuit of customer satisfaction through delivery of top quality services.
For Shareholders: Maximize shareholders’ wealth through a sustained return on their investments.
For Employees: Provide job satisfaction by making IDLC a centre of excellence with opportunity for career development.
For the Society: Contribute to the well being of the society, in general, by acting as a responsible corporate citizen.
Goal
Long term maximization of stakeholders’ value in a socially responsible manner.
Corporate Philosophy
Discharge our functions with proper accountability for actions and results and bind ourselves to the highest ethical standards.
Pattern of Shareholding of IDLC Finance Limited
The shareholding structure at the year-end of 2010 is given below:
Table 2: Shareholding Structure (2010)
| Name of Shareholders | Shares held
as a % of total holdings |
| Sponsors/Directors: | |
| The City Bank Limited | 28.37 |
| Sadharan Bima Corporation | 7.62 |
| Sub-Total | 35.99 |
| GENERAL | |
| Institutions : | |
| Eskayef Bangladesh Limited | 8.00 |
| Mercantile Bank Limited | 7.50 |
| Reliance Insurance Company Limited | 7.00 |
| Transcraft Limited | 4.01 |
| Eastern Bank Limited | 3.33 |
| Bangladesh Lamps Limited | 1.32 |
| ICB | 1.16 |
| Marina Apparels Limited | 1.00 |
| Other Institutions | 17.38 |
| Sub total | 50.70 |
| Individuals : | |
| General Public (Individual) | 13.31 |
| Sub total | 13.31 |
| Total Holdings | 100.00 |
Source: IDLC Annual Report 2010
CAPITAL
Authorized : BDT 1,000,000,000 (10,000,000 ordinary shares of BDT 100 each)
Paid-up : BDT 600,000,000 (6,000,000 ordinary shares of BDT 100 each)
Figure 1: Pattern of Share Holding of IDLC Finance Limited
Organizational Structure
The organizational structure of IDLC Finance Limited is as follows-
Figure 2: Organization Structure of IDLC Finance Limited
Diversity of Services
To ensure steady and long term growth as well as to sharpen its competitive edge in a changing and challenging business environment, IDLC always endeavors to diversify into other financial services which have long term prospects. In 1997, it expanded its range of services by introducing Housing Finance and Short Term Finance. In early 1999, after getting license of Merchant Banking from Securities and Exchange Commission, IDLC started its operation of underwriting, issue management, corporate financing and other investment banking related services.
Leasing: Full payout lease finance for any type of machinery and equipment required in the manufacturing and service sectors.
Term Loans: Term loan is offered for corporate and project financing to establish project or to expand business or re-financing existing financing. IDLC’s Term Loan offers:
Funding for specific purposes
Competitive interest rates, fixed or variable
Flexible terms
Variety of collateral options
Short Term Finance (STF): STF provides Factoring of Accounts Receivables and Work Order Finance services to assist in the finance and management of accounts receivables and maximize business growth.
Home Loan & Real Estate:
Individual House Loan Scheme for: Purchase of apartments, Construction of house, Renovation & extension of house and Purchase/construction of house for the employees under corporate house finance scheme.
Developers’ Finance Scheme for: Construction of Apartments projects
Corporate Finance Scheme for: Purchase of office space/chamber/display center, Construction/purchase of commercial building, Constructions of commercially viable projects and Constructions of industrial buildings like factory, godown, warehouse etc.
Corporate Finance
Syndication services for large-scale investments
Advisory services such as corporate counseling, project counseling, capital restructuring, financial engineering, etc.
Merger and acquisition services
Securitization of assets
Merchant Banking
Issue Management
Underwriting
Private placement of stocks
Trusteeship management
SME Division
SME
Retail Products
Research Activities of IDLC
Except for the regular functions, the credit risk management department is also responsible for conduction research activities on the industrial sectors of the country. CRM department has identifies more than fifty industrial sectors of Bangladesh and planned to develop a database on those.
This research-based program started mid-way in 2003 and has so far covered sixteen industries. Usually industrial data is collected from secondary sources by the internal staffs of the interns doing their internship at IDLC, are assigned on some industries.
This research activity can be regarded as a proactive approach. The results are used in preparing internal reports, developing credit risk assessment criteria and briefing the relationship management team in business development activities.
Consolidated Key Operating and Financial Highlights
Table 3: Financial & Operating Highlights for the year 2010 (BDT in millions)
Source: IDLC Annual Report 2010
Financial Performance of IDLC Finance Limited
Liquidity Ratio
Figure3: Current of IDLC Finance Limited
IDLC Finance Limited observes current ratio to check the liquidity position of the firm. Over the years,the firm has been able to maintain standard level of current ratio. Except for 2006, the ratio has always been above 1.
Solvency Ratio
Figure4: Debt Equity Ratio of IDLC Finance Limited
To check the solvency position of the firm, debt equity ratio and financial expense coverage ratio are observed. Being a financial organization, IDLC operates its business with borrowed fund. So, historically we can observe, that debt equity ratio is high.In 2010, we have observed a complete opposite scenario, due to comparetively high mobilization of deposit and low borrowing due to high call money rate at the end of this fiscal year.
Profitability Ratio
Figure5: Return on Asset Figure6: Return on Shareholder’s Equity
Profitability ratio is checked with return on asset and return on shaheholder’s equity. The profit of the firm has increased over the years. As a result the ROA and ROE both have increased over the years. It shows gradually increasing financial condition.
Valuation Ratio
Figure7: Valuation Ratio of IDLC Finance Limited
Valuation ratios are observed with three ratios: earning per share (EPS), Dividen per share (DPS), and price earnings ratio (PE). EPS has increased significantly over the years due to increased profitability. It has also been seen through return on equity. DPS has also increased over the years. But in 2008, it decreased to 35 from 40 in 2007. PE ratio has remained quite stable over the years as increased earnings has been accompanied by increased price.
Non-performing Loan Ratio
Figure8: Non-performing Loan Ratio of IDLC Finance Limited
Non -performing loan ratio is very important ratio, to judge the financing expertise of the firm. The non performing loan ratio has significantly decreased over the years. It shows that, the CRM division has been able to provide financing facility to good clients and thus bad loans have decreased significantly over the years. In fact, IDLC is competing to maintain lowest level of NPL rate in the market.
SWOT Analysis
Strength
1) Reputation and Brand Image: IDLC is well-reputed company and has developed a brand image that is recognized by the customers. IDLC is an international joint-venture company and its shareholders have long records of sustainability and reliability in their respective fields. IDLC is one of the esteemed names in financial market of Bangladesh. Since 1985, IDLC has marked its journey through introduction of various innovative products and thus meeting the needs of large corporate clients.
2) Product Portfolio: IDLC has diverse product portfolio for customers which made them second to none in Non-Banking Financial Industry.
3) Quality Customer Portfolio: IDLC has a Credit Risk Management department of Multinational standard which enables the company to maintain a quality customer portfolio.
4) Reputation: It is the mostly reputed non banking financial institution in the country.
5) Existence: IDLC is operating in the Bangladesh financial market for the last 24 years. Today, it has expanded its operations in Chittagong, Bogra and Sylhet city.
6) Credit Rating: Awarded A+ rating by CRISL.
7) Institutional Shareholding: Mostly institutional shareholders. The institutions are reputed business houses their respective fields in Bangladesh.
8) Human Resources: The Company has competent management team. The overall work force of the company is considered as key resources for the organization. IDLC personnel are motivated, competent, energetic and creative. The company provides utmost support in terms of both technical and moral.
9) Operational Efficiency: IDLC provides customized solution to their customers to adjust their need. The company processes the loan applications quickly and smoothly. The sanction and disbursement of the loans are hassle-free.
10) Employee Empowerment: At IDLC decision-making is free flowing and transparent. Every appraiser is given ample opportunity to exercise his/her creativity in accommodating a customer. Approvers are open for any discussion and sanction is largely based upon recommendation of the appraisers. The open and free flow of communication ensures clarification of any queries in no time–from any level of hierarchy. Reasonable suggestions are not only welcome but are highly appreciated. Effective suggestions by the employees are immediately set for action. This flexibility has helped IDLC a lot in shaping up its operations into a level of efficiency and to be an excellent performer in case of loan recovery.
11) Knowledge Base: Being the oldest and largest non banking financial organization, IDLC has always tried for innovation. Those innovations were in the form of creation of a new financing avenue in a new industry, creation of new financial products, advisory services to the industry players to acquire modern technology and others. During the last 24 years, the organization has learned some invaluable knowledge, regarding several industries, market dynamics, and local as well as global economy.
12) Large Customer Base: Today, IDLC has more than 3,000 satisfied customers served by its personal finance division and other business units. It has also around 2,000 valued customers operating is the stock market. It has very good relationship with the NRBs
Weakness
1) High Cost of Fund: IDLC as any other NBFIs have high cost of fund in comparison to banks. As NBFIs can take deposit for less than one year from any individuals as banks can do, the deposit base of IDLC is not strong enough to reduce the average cost of fund.
2) More Focus on Volume: Although IDLC has department called Credit Risk Management to monitor the asset quality of the company, still the company sometimes for the sake of profit and past relationship provide loans to customers who at the end hamper the portfolio quality of IDLC.
3) Too Much Diversification: Too much diversification of product and services offering hamper the focus on the core services of the organization.
4) Less People in Liability Marketing: IDLC still employs lesser number of workforces for the aggressive liability marketing in comparison to banks and NBFI like DBH.
5) No Subsidiary in Any Other Field: IDLC does not have any other subsidiary operating other than the financial industry.
6) Focus Problem: IDLC gives less focus on bottom line companies compared to any other institutions. As a large NBFI, it has the ability to focus the bottom line sectors.
7) Weak Inter-departmental Coordination: Still the co-ordination between the inter department is not that much well-organized.
Opportunities
Continuity of Liberalization: Government has continued to liberalize the economy towards more market orientation. This encouraged both local and foreign investors to invest in potential sectors. The privatization plan of government is likely to have positive impact on industrialization.
Foreign Investment in Prospective Sectors: In recent days foreign investment in the various prospective sectors has increased phenomenally. This creates a good opportunity for all financial institutions to enter in the booming new sector.
Local Banks Inefficiency: One of the major reasons for thriving of leasing company in Bangladesh is local banks inefficiency of providing project loan. This phenomenon still persists.
Islamic Wing: IDLC can easily form its own Islamic wing to attract new customers segment. As a result, its revenue will go up.
Threats
High Competition from both Banks and Leasing Companies: Today more than seventy eight banks and leasing companies are almost at the same platform. The products and the target clients are almost same. The existing FIs are continuous threat to the business of corporate division as well as the organization.
Regularity Control of Government: The legal framework of Bangladesh is relatively weak. Lack of effective foreclosure laws and manual land recording system creates possibility of forgery and disputes. This may hinder the loan recovery from the defaulters.
POLICY AND STRATEGY GUIDELINES BY BANGLADESH BANK
This section details fundamental credit risk management policies and strategies that are recommended for adoption by all FIs in Bangladesh. The guidelines contained herein outline general principles that are designed to govern the implementation of more detailed lending procedures and risk grading systems within individual FIs. It is the overall responsibility of FI’s Board to approve FI’s credit risk strategy and significant policies relating to credit risk and its management which should be based on the FI’s overall business strategy. To keep it current, the overall policy and strategy has to be reviewed by the Board, preferably annually.
Credit Risk Policy
Every FI should have a credit risk policy document that should include risk identification, risk measurement, risk grading/ aggregation techniques, reporting and risk control/ mitigation techniques, documentation, legal issues and management of problem facilities. Such policies and procedures shall provide guidance to the staff on various types of lending including Corporate, SME, Consumer, Housing etc. Credit risk policies should:
Provide detailed and formalized credit evaluation/ appraisal process
Provide risk identification, measurement, monitoring and control
Define target markets, risk acceptance criteria, credit approval authority, credit origination/ maintenance procedures and guidelines for portfolio management
Be communicated to branches/controlling offices. All dealing officials should clearly understand the FI’s approach for credit sanction and should be held accountable for complying with established policies and procedures
Clearly spell out roles and responsibilities of units/staff involved in origination and management of credit
In order to be effective, these policies must be clear and communicated down the line. Further any significant deviation/exception to these policies must be communicated to the top management/Board and corrective measures should be taken. It is the responsibility of senior management to ensure effective implementation of these policies duly approved by the Board.
Credit Risk Strategy
The very first purpose of FI’s credit strategy is to determine the risk appetite of the FI. Once it is determined the FI could develop a plan to optimize return while keeping credit risk within predetermined limits. It is essential that FIs give due consideration to their target market while devising credit risk strategy. The credit procedures should aim to obtain an in-depth understanding of the FI’s clients, their credentials & their businesses in order to fully know their customers.
Each FI should develop, with the approval of its Board, its own credit risk strategy or plan that establishes the objectives guiding the FI’s credit-granting activities and adopt necessary policies/ procedures for conducting such activities. This strategy should spell out clearly the organization’s credit appetite and the acceptable level of risk-reward trade-off for its activities
The strategy would, therefore, include a statement of the FI’s willingness to grant facilities based on the type of economic activity, geographical location, currency, market, maturity and anticipated profitability. This would necessarily translate into the identification of target markets and business sectors, preferred levels of diversification and concentration, the cost of capital in granting credit and the cost of bad debts
The strategy should delineate FI’s overall risk tolerance in relation to credit risk, the institution’s plan to grant credit based on various client segments and products, economic sectors, geographical location, currency and maturity
The strategy should provide pricing strategy and ensure that FI’s overall credit risk exposure is maintained at prudent levels and consistent with the available capital
Senior management of a FI shall be responsible for implementing the credit risk strategy approved by the Board.
Lending Guidelines
All FIs should have established “Lending Guidelines” that clearly outline the senior management’s view of business development priorities and the terms and conditions that should be adhered to in order for facilities to be approved. The Lending Guidelines should be updated at least annually to reflect changes in the economic outlook and the evolution of the FI’s facility portfolio, and be distributed to all lending/marketing officers.
Any departure or deviation from the Lending Guidelines should be explicitly identified in credit applications and a justification for approval provided. The Lending Guidelines should include the following:
Industry and Business Segment Focus: The Lending Guidelines should clearly identify the business/industry sectors that should constitute the majority of the FI’s facility portfolio. For each sector, a clear indication of the FI’s appetite for growth should be indicated.
Types of Facilities: The type of facilities that are permitted should be clearly indicated, such as Lease, Term Loan, Home Loan, and Working Capital etc.
Single Borrower/Group Limits/Syndication: Details of the FI’s Single Borrower/Group limits should be included as per Bangladesh Bank guidelines.
Sector Lending Caps: An important element of credit risk management is to establish exposure limits for single obligors and group of connected obligors. FIs are expected to develop their own limit structure while remaining within the exposure limits set by Bangladesh Bank. FIs may establish limits for a specific industry, economic sector or geographic regions to avoid concentration risk.
Product Lending Caps: FIs should establish a specific product exposure cap to avoid over concentration in any one product.
Discouraged Business Types: FIs should outline industries or lending activities that are discouraged. The FI may have segregated sectors to be discouraged.
Facility Parameters: Facility parameters (e.g., maximum size, maximum tenor, and covenant and security requirements) should be clearly stated.
Credit Assessment and Risk Grading
Credit Assessment
A thorough credit and risk assessment should be conducted prior to the granting of a facility, and at least annually thereafter for all facilities. The results of this assessment should be presented in a Credit Application and is reviewed by Credit Risk Management (CRM) for identification and probable mitigation of risks.
All FIs should have established Know Your Customer (KYC) and Money Laundering guidelines which should be adhered to at all times.
Credit Applications should summarize the results of the RMs risk assessment and include, as a minimum, the following details:
Amount and type of facility(s) proposed
Purpose of facilities
Facility Structure (Tenor, Covenants, Repayment Schedule, Interest)
Security Arrangements
Government and Regulatory Policies
Economic Risks
In addition, the following risk areas should be addressed:
Borrower Analysis- The majority shareholders, management team and group or affiliate companies should be assessed. Any issues regarding lack of management depth, complicated ownership structures or inter-group transactions should be addressed, and risks mitigated.
Industry Analysis- The key risk factors of the borrower’s industry should be assessed. Any issues regarding the borrower’s position in the industry, overall industry concerns or competitive forces should be addressed.
Supplier/Buyer Analysis- Any customer or supplier concentration should be addressed, as these could have a significant impact on the future viability of the borrower.
Historical Financial Analysis- Preferably an analysis of a minimum of 3 years historical financial statements of the borrower should be presented. The analysis should address the quality and sustainability of earnings, cash flow and the strength of the borrower’s balance sheet.
Projected Financial Performance- Where term facilities (tenor > 1 year) are being proposed, a projection of the borrower’s future financial performance should be provided, indicating an analysis of the sufficiency of cash flow to service debt repayments.
Credit Background- Credit application should clearly state the status of the borrower in the CIB (Credit Information Bureau) report. The application should also contain liability status with other Banks and FI’s and also should obtain their opinion of past credit behavior.
Account Conduct- For existing borrowers, the historic performance in meeting repayment obligations (trade payments, cheques, interest and principal payments, etc) should be assessed.
Adherence to Lending Guidelines- Credit Applications should clearly state whether or not the proposed application is in compliance with the FI’s Lending Guidelines.
Mitigating Factors- Mitigating factors for risks identified in the credit assessment should be identified. Possible risks include, but are not limited to: margin sustainability and/or volatility, high debt load (leverage/gearing), overstocking or debtor issues; rapid growth, acquisition or expansion; new business line/product expansion; management changes or succession issues; and customer or supplier concentrations.
Facility Structure- The amounts and tenors of financing proposed should be justified based on the projected repayment ability and facility purpose.
Purpose of Credit- FIs have to make sure that the credit is used for the purpose it was borrowed. Where the obligor has utilized funds for purposes not shown in the original proposal, FIs should take steps to determine the implications on creditworthiness.
Project Implementation- In case of a large expansion, which constitutes investment of more than 30% of total capital of a company or for a green field project, project implementation risk should be thoroughly assessed.
Foreign Currency Fluctuation- Credit application should clearly state the assessment of foreign currency risk of the applicant and identify the mitigating factors for its exposure to foreign currency.
Security- A current valuation of collateral should be obtained and the quality and priority of security being proposed should be assessed internally and preferably by a third party valuer.
Type of Control on Cash Flow- The credit application should contain and assess if there is any control on the borrowers cash flow for securing the repayment. This may include payment assignment from export proceed, payment assignment from customers of the borrower etc.
Exit Option- Credit application should state the exit option from the borrower in early identification of deterioration of grading of the borrower.
Name Lending- Credit proposals should not be unduly influenced by an over reliance on the sponsoring principal’s reputation, reported independent means, or their perceived willingness to inject funds into various business enterprises in case of need.
Appendix contains a template for credit application.
Risk Grading
The Credit Risk Grading (CRG) is a collective definition based on the pre-specified scale and reflects the underlying credit-risk for a given exposure. Credit Risk Grading is the basic module for developing a Credit Risk Management system. Credit risk grading is an important tool for credit risk management as it helps the Financial Institutions to understand various dimensions of risk involved in different credit transactions. The aggregation of such grading across the borrowers, activities and the lines of business can provide better assessment of the quality of credit portfolio of a FI.
The credit risk grading system is vital to take decisions both at the pre-sanction stage as well as post-sanction stage. At the pre-sanction stage, credit grading helps the sanctioning authority to decide whether to lend or not to lend, what should be the lending price, what should be the extent of exposure, what should be the appropriate credit facility, what are the various facilities, what are the various risk mitigation tools to put a cap on the risk level. At the post-sanction stage, the FI can decide about the depth of the review or renewal, frequency of review, periodicity of the grading, and other precautions to be taken. Risk grading should be assigned at the inception of lending, and updated at least annually. FIs should, however, review grading as and when adverse events occur. A separate function independent of facility origination should review risk grading.
1 Use of Credit Risk Grading
The Credit Risk Grading matrix allows application of uniform standards to credits to ensure a common standardized approach to assess the quality of individual obligor, credit portfolio of a unit, line of business, the FI as a whole.
CRG would provide a quantitative measurement of risk which portrays the risk level of a borrower and enables quick decision making.
As evident, the CRG outputs would be relevant for individual credit selection, wherein either a borrower or a particular exposure/facility is rated. The other decisions would be related to pricing (credit-spread) and specific features of the credit facility.
Risk grading would also be relevant for surveillance and monitoring, internal MIS and assessing the aggregate risk profile of an FI. It is also relevant for portfolio level analysis.
CRG would provide a quantitative framework for assessing the provisioning requirement of a FI’s credit portfolio.
Risk Grading for Corporate and SME
The proposed CRG scale is applicable for both new and existing borrowers.
It consists of 8 categories, of which categories 1 to 5 represent various grades of acceptable credit risk and 6 to 8 represent unacceptable credit risk. However, individual FI depending on their risk appetite may implement more stringent policy.
Table 4: Risk Grade Matrix
| Risk Rating | Short Name | Grade | Definition |
| Superior – Low Risk | SUP | 1 | Credit facilities, which are fully secured i.e. fully cash covered.
Credit facilities fully covered by government guarantee. Credit facilities fully covered by the guarantee of a top tier international Bank. |
| Good – Satisfactory Risk | GD | 2 | Strong repayment capacity of the borrower
The borrower has excellent liquidity and low leverage. The company demonstrates consistently strong earnings and cash flow certainty. Borrower has well established, strong market share. Very good management skill & expertise. Credit facilities fully covered by the guarantee of a top tier local Bank. Aggregate Score of 85 or greater based on the Risk Grade Score Sheet |
| Acceptable – Fair Risk | ACCPT | 3 | These borrowers are not as strong as GOOD Grade borrowers, but still demonstrate consistent earnings, cash flow certainty and have a good track record.
Borrowers have adequate liquidity, cash flow and earnings. Credit in this grade would normally be secured by acceptable collateral (1st charge over inventory / receivables / equipment / property). Acceptable management Acceptable parent/sister company guarantee Aggregate Score of 75-84 based on the Risk Grade Score Sheet |
| Marginal – Watch list | MG/ WL | 4 | This grade warrants greater attention due to conditions affecting the borrower, the industry or the economic environment.
These borrowers have an above average risk due to strained liquidity, higher than normal leverage, thin cash flow and/or inconsistent earnings. Weaker business credit & early warning signals of emerging business credit detected. The borrower incurs a loss Facility repayments routinely fall past due Account conduct is poor, or other untoward factors are present. Credit requires attention Aggregate Score of 65-74 based on the Risk Grade Score Sheet |
| Special Mention | SM | 5 | This grade has potential weaknesses that deserve management’s close attention. If left uncorrected, these weaknesses may result in a deterioration of the repayment prospects of the borrower.
Severe management problems exist. Facilities should be downgraded to this grade if sustained deterioration in financial condition is noted (consecutive losses, negative net worth, excessive leverage), An Aggregate Score of 55-64 based on the Risk Grade Score Sheet. |
| Substandard | SS | 6 | Financial condition is weak and capacity or inclination to repay is in doubt.
These weaknesses jeopardize the full settlement of facilities. Bangladesh Bank criteria for sub-standard credit shall apply. An Aggregate Score of 45-54 based on the Risk Grade Score Sheet. |
| Doubtful and Bad
(non-performing) |
DF | 7 | Full repayment of principal and interest is unlikely and the possibility of loss is extremely high.
However, due to specifically identifiable pending factors, such as litigation, liquidation procedures or capital injection, the asset is not yet classified as Bad & Loss. Bangladesh Bank criteria for doubtful credit shall apply. An Aggregate Score of 35-44 based on the Risk Grade Score Sheet. |
| Loss
(non-performing) |
BL | 8 | Credit of this grade has long outstanding with no progress in obtaining repayment or on the verge of wind up/liquidation.
Prospect of recovery is poor and legal options have been pursued. Proceeds expected from the liquidation or realization of security may be awaited. The continuance of the facility as a bankable asset is not warranted, and the anticipated loss should have been provided for. This classification reflects that it is not practical or desirable to defer writing off this basically valueless asset even though partial recovery may be affected in the future. Bangladesh Bank guidelines for timely write off of bad facilities must be adhered to. Legal procedures/suit initiated. Bangladesh Bank criteria for bad & loss credit shall apply. An Aggregate Score of less than 35 based on the Risk Grade Score Sheet. |
Source: Credit Risk Management-Industry Best Practices by Bangladesh Bank
Risk Rating for Consumer Lending
For consumer lending, FIs may adopt credit-scoring models for processing facility applications and monitoring credit quality. FIs should apply the above principles in the management of scoring models. Where the model is relatively new, FIs should continue to subject credit applications to rigorous review until the model has stabilized.
Ratings Review
The rating review can be two-fold:
Continuous monitoring by those who assigned the grading. The Relationship Managers (RMs) generally have a close contact with the borrower and are expected to keep an eye on the financial stability of the borrower. In the event of any deterioration the grading are immediately revised /reviewed.
Normally CRG should be reviewed at least once in a year. For risk grades starting from 5 to 8, CRG should be reviewed in every six months.
Secondly the risk review functions of the FI or business lines also conduct periodical review of grading at the time of risk review of credit portfolio.
Approval Authority
All commercial activities, which commit the FI to deliver risk sensitive products, require prior approval by authorized committees/individuals. A FI may have the Board, Management/Executive Committee, and Credit Committees for reviewing and approving financing proposals. The concerned CRM officials should be the owner of their independent review and identification of risks based on the credit application. The authority to sanction/approve facilities must be clearly delegated by the Managing Director/CEO & Board to the Corporate Center and further down to the Business Units. Business Units are independent and responsible for managing all business activities within the approved limits.
Segregation of Duties
Adequate segregation of duties is a prerequisite for an effective system of internal control. To be adequate, segregation must ensure that the following functions are performed by persons independent of each other, although, within limits, certain may be combined so long there is adequate supervision:
Credit Approval/Risk Management/Recovery
Relationship Management/Marketing
Credit Administration
The credit approval team will be independent from the sales and branch team who will evaluate and approve the facility. The Credit Administration department will check and ensure the documentation and disburse the facilities. This will ensure better control of the FI asset and mitigate the risk of compromise of the duties. The purpose of the segregation is to improve the knowledge levels and expertise in each department, to impose controls over the disbursement of authorized facilities and obtain an objective and independent judgment of credit proposals.
Internal Audit
FIs should have a segregated internal audit/control department charged with conducting audits of all departments
Internal audit should verify the continuing adequacy and applicability of credit risk management policies and procedures, provide an independent assessment of the credit portfolios’ existence, quality and value, the integrity of the credit process, and promotes detection of problems.
Every year, internal audit should prepare an auditing plan to be approved by the Board according to which the audits are carried out. This auditing plan should be carried out in a risk-oriented manner, taking into account size and nature of the credit institution, as well as type, volume, complexity, and risk level of the FI’s activities
A written audit report has to be prepared following each audit.
Internal auditing should monitor the swift correction of any problems detected in the audit as well as the implementation of its recommendations in a suitable form, and if necessary to schedule a follow-up audit.
The following audit areas are particularly relevant:
All operational and business procedures within the credit institution
Risk management and risk management control
The internal review system
The FI’s internal rules and directives
All mandatory audit areas (especially large-exposure investments, money laundering and compliance, diligence, reporting requirements, securities trading book)
Credit audit is conducted on-site, i.e. at the branch which has appraised the advance and where the main operative credit limits are made available
Reports on conduct of accounts of allocated limits are to be called from the corresponding branches
Credit auditors may visit borrowers’ factory/ office premise
Preferred Risk Management Structure
To maintain FI’s overall credit risk exposure within the parameters set by the Board of directors, the importance of a sound risk management structure is second to none. The appropriate organizational structure must be in place to support the adoption of the policies detailed in Section 1 of these guidelines. While the FIs may choose different structures, it is important that such structure should be commensurate with institution’s size, complexity and diversification of its activities. The key feature is the segregation of the Marketing/Relationship Management function from Approval/ Risk Management/ Administration functions. It must facilitate effective management oversight and proper execution of credit risk management and control processes. The following chart represents the preferred risk management structure
Figure 9: Preferred Risk Management Structure
Key Responsibilities of Credit Risk Management
Oversight of FI’s credit policies, procedures and controls relating to all credit risks arising from corporate/commercial/institutional/personal/ treasury operations
Oversight of the FI’s asset quality
To ensure that lending executives have adequate experience and/or training in order to carry out job duties effectively.
Credit Functions
To review Credit Applications recommended by RM and to provide independent risk assessment and recommendation to MD/CEO/Board for approval
To provide advice/assistance regarding all credit matters to line management/RMs
Monitoring Functions
Directly manage all Substandard, Doubtful & Bad and Loss accounts to maximize recovery and ensure that appropriate and timely facility loss provisions have been made
Procedural Guidelines
This section outlines of the main procedures that are needed to ensure compliance with the policies.
Approval Process
The approval process must reinforce the segregation of Relationship Management/Marketing from the approving authority. The responsibility for preparing the Credit Application should rest with the RM within the business unit. Credit Applications should be recommended for approval by the RM team and forwarded to CRM for their review and assessment. The credit should subsequently be approved by proper approval committee. The approval process may vary among FI’s depending on the types of products and exposure. For example, lending to Corporate and SME’s is mostly unstructured due to diverse nature of risk exposure. On the other hand, consumer lending is mostly structured by standardizing the product and risk aspects of individuals.
Credit Administration
The Credit Administration function is critical in ensuring that proper documentation and approvals are in place prior to the disbursement of financial facilities. For this reason, it is essential that the functions of Credit Administration be strictly segregated from Relationship Management/Marketing in order to avoid the possibility of controls being compromised or issues not being highlighted at the appropriate level. Ongoing administration of the credit portfolio is an essential part of the credit process. Credit administration function is basically a back office activity that support and control extension and maintenance of credit. A typical credit administration unit performs following functions:
Documentation
It is the responsibility of credit administration to ensure completeness of documentation (facility agreements, guarantees, transfer of title of collaterals etc) in accordance with approved terms and conditions.
Disbursement
Disbursements under facilities should only be made when all security documentation is in place. CIB report should reflect/include the name of all the lenders with facility, limit & outstanding.
Credit Monitoring
After the facility is approved and draw down allowed, the facility should be continuously watched over. These include keeping track of borrowers’ compliance with credit terms, identifying early signs of irregularity, conducting periodic valuation of collateral and monitoring timely repayments.
Facility Repayment
The obligors should be communicated ahead of time as and when the principal/markup installment becomes due.
Custodial Duties
Facility disbursements and the preparation and storage of security documents should be centralized in the regional credit centers. Appropriate insurance coverage should be maintained on assets pledged as collateral.
Compliance Requirements
All required Bangladesh Bank returns should be submitted in the correct format in a timely manner. Bangladesh Bank circulars/regulations are maintained centrally, and advised to all relevant departments to ensure compliance
Credit Monitoring
To minimize credit losses, monitoring procedures and systems should be in place that provide an early indication of the deteriorating financial health of a borrower. At a minimum, systems should be in place to report the following exceptions to relevant executives in CRM and RM team:
Past due principal or interest payments, past due trade bills, account excesses, and breach of facility covenants
Non-receipts of financial statements on a regular basis and any covenant breaches or exceptions made
Action not taken on time for findings of any internal, external or regulator inspection/audit
All borrower relationships/facilities are reviewed and approved through the submission of a Credit Report at least annually.
Refer to the Credit Report format attached as Appendix.
Credit Recovery
The Recovery Unit (RU) of CRM should directly manage accounts with sustained deterioration (a Risk Rating of Sub Standard (6) or worse). FIs may wish to transfer EXIT accounts graded 4-5 to the RU for efficient exit based on recommendation of CRM and Corporate FI. The RU’s primary functions are:
Determine Account Action Plan/Recovery Strategy
Pursue all options to maximize recovery, including placing customers into receivership or liquidation as appropriate
Ensure adequate and timely loan loss provisions are made based on actual and expected losses
Regular review of grade 6 or worse accounts
The management of problem facilities (NPLs) must be a dynamic process, and the associated strategy together with the adequacy of provisions must be regularly reviewed.
NPL Account Management
All NPLs should be assigned to an Account Manager within the RU, who is responsible for coordinating and administering the action plan/recovery of the account, and should serve as the primary customer contact after the account is downgraded to substandard. Whilst some assistance from Corporate FI/Relationship Management may be sought, it is essential that the autonomy of the RU be maintained to ensure appropriate recovery strategies are implemented.
Account Transfer Procedures
Within 7 days of an account being downgraded to substandard (grade 6), a Request for Action should be completed by the RM and forwarded to RU for acknowledgment. The account should be assigned to an account manager within the RU, who should review all documentation, meet the customer, and prepare a Classified Loan Review Report within 15 days of the transfer. Recovery Units should ensure that the following is carried out when an account is classified as Sub Standard or worse:
Facilities are withdrawn or repayment is demanded as appropriate. Any drawings or advances should be restricted, and only approved after careful scrutiny and approval from appropriate authorities.
CIB reporting is updated according to Bangladesh Bank guidelines and the borrower’s Risk Grade is changed as appropriate
Loan loss provisions are taken based on Force Sale Value (FSV)
Prompt legal action is taken if the borrower is uncooperative
Rescheduling
FI’s should follow clear guideline for rescheduling of their problem accounts and monitor accordingly. Rescheduling of problem accounts should be aimed at a timely resolution of actual or expected problem accounts with a view to effecting maximum recovery within a reasonable period of time.
Purpose of Rescheduling:
To provide for borrower’s changed business condition
For better overdue management
For amicable settlement of problem accounts
Modes of Rescheduling:
Rescheduling can be done through adopting one or more of the following means.
Extension of financing term keeping lending rate unchanged
Reduction of lending rate keeping financing term unchanged
Both reduction of lending rate and extension of financing term
Bodily shifting of payment schedule
Deferment of payment for a short-term period with or without extending the maturity date.
However, under any circumstances reschedule period must not exceed economic life of the asset.
Non Performing Loan (NPL) Monitoring
On a quarterly basis, a Classified Loan Review (CLR) should be prepared by the RU Account Manager to update the status of the action/recovery plan, review and assess the adequacy of provisions, and modify the FI’s strategy as appropriate.
NPL Provisioning and Write Off
The guidelines established by Bangladesh Bank for CIB reporting, provisioning and write off of bad and doubtful debts, and suspension of interest should be followed in all cases. Regardless of the length of time a facility is past due, provisions should be raised against the actual and expected losses at the time they are estimated. The Force Sale Value (FSV) for accounts grade 6 or worse. Any shortfall of the Force Sale Value compared to total facility outstanding should be fully provided for once an account is downgraded to grade 7.
SME SCENARIO IN CONTEXT OF BANGLADESH
Bangladesh is a densely populated country. Job opportunity here is very scanty; Unemployment rate is approximately 40%. Population below poverty line is 36%. Therefore, it is the prime concern for the nation to generate income through creation of job opportunity & employment. Creation of job opportunity at large scale by us is not possible. What can be done better is to help self-employment through financial support. There are many small and medium entrepreneurs in the country that have innovative idea, spirit and potentiality to do something productive for local consumers as well as export abroad. They can generate income and contribute to the GDP. They may also provide employment to other people also. Development and growth of Small and Medium Enterprise is vital for national development. In the context of Bangladesh, the development of Small and Medium Enterprises (SMEs) can be considered as a vital instrument for poverty alleviation and ensure the rapid industrialization. The performance of SMEs of Bangladesh especially in terms of emp